When is Vendor Managed Inventory Good for the Retailer? Impact of Relative Margins and Substitution Rates

When customers cannot find a particular item at a retailer because it is out of stock, they are likely, with some probability, to switch to a substitute product from another manufacturer at the same store. Analyzing a two-product full substitution case, this paper examines two beliefs argued in the literature: (1) that, under Vendor Managed Inventory (VMI), the retailers would benefit because manufacturers would increase stocking quantities to avoid losing sales to a competitor and (2) that substitution benefits retailers who make a sale regardless. We find that the first proposition, while appealing, is simply not true for many cases. We also find that the second proposition does not hold for a wide number of cases. We contribute to the understanding of the inherent tradeoffs involved in deciding to use RMI or VMI in the presence of competing, substitute products.